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Gold Bounces on ECB Inflation Warning

Commodities / Gold & Silver Mar 26, 2008 - 10:21 AM GMT

By: Adrian_Ash

Commodities THE PRICE OF PHYSICAL GOLD bounced 1.3% into the start of London trade on Wednesday, reaching a one-week high above $948 per ounce as the US open drew near.

Global stock markets ticked lower, meantime, and crude oil prices rose 1.6% to $102.85 per barrel.


The Dollar dropped to ¥99.05 on the forex market, denting the export-heavy Japanese Nikkei stock index by 0.3%. The US currency also lost 1.5¢ to the Euro after a surprise jump in both European industrial output and German consumer confidence.

"The German number was very strong," noted Mario Innecco at MF Global in London to Bloomberg earlier. "That's helped the Euro and hurt the Dollar and that's why gold has bounced back."

Yesterday the Conference Board put US consumers' expectations for the future at their worst since 1974. The ABC report for last week confirmed the longest run of negative sentiment in 14 years.

Changes in the Gold Price now show a correlation with the Euro/Dollar exchange rate of 0.62 for the last 12 months, according to Bloomberg data. This time in 2007, the connection stood at 0.46.

But if investing in gold really was "all about the Euro", their correlation vs. the Dollar would be more than twice as strong at 1.0. What's more, the Gold Price in Euros would not have gained 19% over the last year.

"Last week's sell-off has the potential to be very constructive for the Gold Price ," says today's note from Brandon Lloyd at Mitsui in Sydney .

"Technically, it held the long term trend, and now that it has shaken out the irrational exuberance we saw earlier in the year, the short-term target is $950."

In sharp contrast to the Federal Reserve's record-breaking demolition of US Dollar interest rates, Jean-Claude Trichet – head of the European Central Bank – today downplayed the chance a cut in Eurozone interest rates any time soon.

Speaking to the European Parliament in Brussels , Trichet warned that consumer-price inflation will remain "significantly above" the ECB's target of 2% throughout 2008 thanks to "vigorous money and credit growth."

Yet Trichet congratulated himself for pouring short-term loans into the European money market – and promised more loans to come – claiming that "in this period of acute turbulences...the ECB has succeeded in containing deviation of very short-term interest rates from the official interest rate."

At yesterday's regular weekly auction of 7-day funds the ECB lent out €216 billion ($337bn) – one third more than estimated.

Tuesday's "Term Auction" at the Federal Reserve was also massively over-subscribed, with US banks bidding for $88.9 billion compared with $50bn on offer – "an excess of demand almost as great as the previous auction two weeks ago, before the collapse of Bear Stearns," says the Financial Times .

Here in London, the open-market interest rate for three-month loans reached a new high for 2008 to date, nearly 75-basis points above the Bank of England's target rate at 5.995%.

This gap between "Libor" and target rates almost matches the gaps which forced joint central-bank intervention in Sept., Dec. and Feb.

The Financial Services Authority in London today admitted "a lack of adequate oversight and review" in its regulation of the failed Northern Rock – one of the UK's top 5 mortgage lenders.

Shares in Deutsche Bank meantime fell 2.2% at the opening after Germany's biggest retail bank issued a profits warning.

"In the near-term, fundamental value will not mean very much" for Gold Prices reckons Tony Lesiak, an analyst at UBS, because "positioning and the need to raise liquidity will determine what happens to precious metals – and indeed other asset classes.

But looking at the broader outlook for rising inflation and falling bank assets, "this environment is one where gold should do well," he says in a research note.

"Although de-leveraging may prevent [gold] from moving higher, it should certainly outperform other metals and has a genuine chance of trading much higher should the Dollar weaken further and de-leveraging become overwhelmed by safe haven buying."

Lesiak says gold may double in due course as it plays "catch up" with the surging price of crude – now trading significantly above its long-term historic ratio to the Gold Price .

By Adrian Ash
BullionVault.com

Gold price chart, no delay | Free Report: 5 Myths of the Gold Market
City correspondent for The Daily Reckoning in London and a regular contributor to MoneyWeek magazine, Adrian Ash is the editor of Gold News and head of research at www.BullionVault.com , giving you direct access to investment gold, vaulted in Zurich , on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2008

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

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